As the frenzy over small-time, videogame retailer GameStop continues, Associate Dean Gail Henderson explains what it’s all about and shares her insight on how it could adversely affect the capital markets, and more.  

I think GameStop provided everyone with a much-needed diversion and a feel-good, narrative about Main Street beating Wall Street at its own game. It also pushed short-selling and hedge funds into the popular imagination in a way we haven’t seen before. 

Short-selling is a way to make money by betting against a stock. Short-sellers borrow the stock from another investor or a broker, sell it at the current, high price, and then buy it back once the price drops, and pocket the difference. Short-selling is high risk, because the potential losses are infinite if the stock price doesn’t fall but continues to rise – as it did last week with GameStop – and the short sellers are forced to buy it while the price is still high.

Hedge funds have a broad investment mandate to “beat the market,” that is, to generate a return above the market as a whole, using a range of techniques, including short-selling. To invest in a hedge fund, you need a lot of money, like in the six or seven figure range, that you’re willing to lock in for a specified period of time. The hedge fund manager collects management fees for managing the fund, but also invests their own money.

Publicly-listed companies have long expressed concerns about what are referred to as “activist” short-sellers: hedge funds that take a short position on a company’s stock, and then start sharing negative information, possibly on social media, which of course may negatively affect the stock price and help the short-seller win their bet.

The regulatory concern with activist short-sellers is that while the public companies are subject to strict disclosure obligations, and can be liable if they make misleading statements, activist short-sellers are not. Just in December, the Canadian Securities regulators announced a consultation on this issue.

No-fee trading platforms like RobinHood and WealthSimple facilitate more frequent trading, and along with social media, helped make the GameStop revenge on the short-sellers possible. But at some point, these stock prices will have to come back down to earth, and investors who borrowed to get in on the action could end up in a deep hole. Another concern is that some investors will continue to chase the high of the big returns from last week, but just get in deeper and deeper.

But there are bigger concerns here as well. Securities regulators in Canada have a mandate “to foster fair and efficient capital markets” and confidence in those markets. Things like WallStreetBets are responding to the perception that the capital markets are like a casino, where the house, (in this case the house includes institutional investors like the hedge funds targeted by the GameStop short-squeeze), always wins. On the other hand, the more the capital markets start to resemble a high-stakes poker game, the more this will undermine confidence in the fairness and efficiency of markets, and in turn harm the ability of the capital markets to serve their actual purpose, which is to finance the real economy, the companies making things like vaccines, ventilators, and masks. 

Professor Gail Henderson, Associate Dean of Faculty Relations, researches and teaches in the areas of corporate law, corporate governance, corporate social responsibility, securities regulation, and the regulation of financial institutions.